Scope for switching in drawdown reforms

New rules for income drawdown plans will make them less restrictive, says Justin Harper

12:00AM GMT 08 Nov 2000

CHANGES to the rules governing income drawdown plans, originally expected to come into force on October 1, and then put off, have been delayed for a third time.

The new rules will, among other things, remove one of the most irritating restrictions imposed on drawdown users at the moment: the inability to switch their fund to another provider if they are unhappy with its performance or administration. The proposed changes will also allow investors with more than one drawdown plan to have all their plans reviewed at the same time, thus helping them to keep track of their various investments more easily. But the new rules are not now expected to come into force until April.

Income drawdown plans were introduced a few years ago as an alternative to buying an annuity on retirement. They enable retired people to keep their pension pot invested, while taking an income within prescribed limits. The hope is that, by adopting sensible investment strategies, the pot will continue to grow even after the income has been taken out, enabling the planholder to buy a bigger annuity when the time comes to convert.

The inability to switch providers was one of the biggest restrictions placed on those taking out an income drawdown plan, and its proposed removal has been welcomed by independent financial advisers, who sell the majority of such schemes.

Philip Lewis, of the Income Drawdown Advisory Bureau, said: "There will be a lot of people who will want to move their funds, and now they have the chance to do so. They may not necessarily be in poorly performing funds. They are more likely to be in the wrong funds.

"Many people were overly cautious with their income drawdown pot, choosing to invest in cash and gilt funds rather than those with prospects of higher growth. Some investors would benefit from being in more heavily-backed equity funds, especially if they require a higher level of income."

People are now looking at the low annuity rates and realising that they need to invest in areas with greater potential for growth, so that they will be able to buy a bigger annuity income when the time comes. But, Mr Lewis added, investors now opting for the equity route should make sure to leave three years' worth of income in cash.

He said: "You don't want to be drawing an income from your equity investments for at least three years as they are a long-term investment, so you need to keep some of your pension pot in cash to provide the ongoing income from the fund."

The relaxation of the income drawdown rules means that investors should also take even greater notice of the charges their financial adviser takes out of their fund. Consumers can be charged up to six per cent of the value of their fund by a financial adviser for operating income drawdown.

The danger is that the opportunity to switch providers will allow unscrupulous financial advisers to transfer your plan unnecessarily. This is known as churning - something advisers have been accused of doing with other investments such as unit trusts, purely to put more money into their pockets. This could cause further concern for the Government, which is already keeping a close eye on drawdown plans, as more and more retired people decide to delay buying an annuity and opt for income drawdown instead.

According to figures from the Association of British Insurers (ABI), the number of new income drawdown contracts has jumped from 11,000 in 1996 to 16,000 last year. The ABI has expressed concern about the reasons behind this huge jump in contracts. The Chartered Insurance Institute has also voiced its worries and predicts that income drawdown could become the next mis-selling scandal after those concerning personal pensions and endowment mortgages. When they come into force, the new rules are unlikely to calm these fears.

Investors also need to bear in mind that an annual charge of between 0.25 and 0.5 per cent is made to cover the costs of yearly reviews of income drawdown plans. The value of the fund and prevailing annuity rates need to be reviewed, since an annuity must be bought by the time a person is 75 years old. Plans are generally reviewed once every three years. But the ability to transfer your income drawdown plan to another provider may signify a greater need for more frequent reviews.

Steven Cameron, manager of pensions development at Scottish Equitable, says that the impact of the income drawdown changes will vary from provider to provider. He said: "If an investor is unhappy with their income drawdown investment, they should already have the choice to move it to another fund run by their existing provider. If a client doesn't like any of the other funds we offer, we have an external link, so we still handle the administration but their money is invested with another provider."

But some providers did not have external links, leaving an investor tied to only one provider's funds. Mr Cameron said: "The new rules will definitely help people stuck with one provider who has a limited choice of funds. It is also good news for those who are unhappy with their present provider's administration."

The change to the Inland Revenue rules also streamlines administration of income drawdown plans, which can be quite costly and eat into the pension fund. Under the old rules, an income drawdown scheme had to be reviewed on the third anniversary of the start of the plan, so an investor with more than one drawdown scheme would require a series of reviews. The proposed changes will allow several income drawdown schemes to be reviewed at the same time, regardless of whether they are with different providers.

However, some problems will still remain. According to Mr Lewis, the biggest limitation occurs when it comes to investing your pension pot. He said: "You still won't be able to buy directly into residential property or warrants, invest money in your own company or make various other investments like works of art. These are investments some people may have as personal favourites - although you are still left with a fairly broad choice, which includes stocks and shares, bonds and gilts."

The changes to the Inland Revenue rules are now the subject of further consultation with the pensions industry. Income drawdown providers like Scottish Equitable and Equitable Life have until November 17 to make their comments before the rules are officially changed.

Readers who wish to contact the Telegraph Pension Annuity Service can call the helpline on 0800 783 9239.